How to cope when financial disaster strikes

The UK may be out of recession, but that does not mean people are feeling relaxed about the economic situation.

Official statistics show Britain returned to growth at the end of last year, but other indicators are less healthy. Personal insolvency was up by almost a fifth according to last month’s [May] figures, while unemployment – one of the main factors contributing to insolvency – has risen to its highest rate since 1996.

So how can you protect yourself from the financial consequences of being unable to work – either through redundancy or ill health?

Insurance packages

There are a number of insurance packages – such as income protection and critical illness policies, and loan payment protection insurance – that are designed to help individuals cover household expenses and vital outgoings such as mortgages when their main source of income dries up.

But the extent of the cover, as well as the cost, can vary significantly. That’s why it is vital to understand in advance exactly what your policy offers: for example, under what circumstances it will pay out, how much money you’ll get, and for how long.

Do you need cover?

The first thing to work out is whether you need insurance at all. Ask yourself: how would I cope financially if I lost my job or fell seriously ill?

If you’re single and renting your home, a loss of income might mean you had to move to cheaper accommodation. But it might be less of a blow than redundancy or serious illness would be for someone with a hefty mortgage to service, and a family to provide for.

Equally, check what cover you already have: your employer may have a generous sick-pay policy or offer a larger-than-average redundancy package.

What are the options?

There are several types of protection insurance: all have pros and cons, but some have more cons than others.

Payment protection insurance (PPI): This type of cover has been in the news regularly for the past couple of years, but for the wrong reasons.

PPI is normally sold alongside personal loans or credit cards, and it is supposed to help borrowers carry on making loan or card repayments if they lose their jobs.

But various studies have shown banks and insurance companies pressuring customers into taking out PPI policies, largely because they are very profitable. That’s due to the policies being hugely expensive given the amount of cover they offer, as well as being hard to claim on.

The sale of PPI is now supposed to be tightly regulated, but even so, it is probably best avoided.

Mortgage payment protection insurance (MPPI): Also known as accident, sickness and unemployment (ASU) cover, doesn’t have the same stigma as PPI, and it covers a significant outgoing: your home loan repayments.

You can choose how much of your mortgage to cover, how soon the insurance payments start – for example after 30 or 60 days – as well as how long payment will continue for. This could be one or two years.

Each of these factors will affect the cost of your policy: premiums will be higher the more you cover, the quicker it kicks in, and the longer it pays out for.

But remember that even though your mortgage may be your largest single outgoing every month, there may be other expenses you need to cover – if you can afford to.

Income protection: This is the most comprehensive way of covering any loss of earnings, as its name suggests.

With an income protection policy, you decide how much the insurer will pay out per month if you can no longer work, through redundancy, illness or injury.

What sets this type of cover apart is that it will continue to pay out for much longer – in many cases until retirement age.

The costs will depend on your age, health, amount of cover, and how long it takes before payments start – this can be one, three, six or 12 months.

If you think you would be able to survive on less than you actually earn, consider taking cover out for an amount lower than your salary.

As well as these policies, consider critical illness or life insurance if you are less worried about the risk of redundancy. But also do your homework before up to policies such as these: it is vitally important you are aware of potential catches in the small print to avoid any claim being turned down.

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